The Alternative Answer Daily

Inflation Hedges That Pay Today

The globe is awash in cash. The Fed’s adds $85 billion a month of new liquidity to our system, but even its herculean efforts will be outdone by the Bank of Japan. Negative real interest rates are common. And it seems as if any respectable corporation has scores of billions in the bank. At some point, all that firepower will most likely translate into much higher asset prices.

Indeed, some inflation is the central banks’ plan. They expect it to bail out underwater homeowners, cut sovereign debt, and rejuvenate “animal spirits” and the global economy. And they believe that, just in the nick of time, they’ll be able to suck the liquidity back from the system and prevent serious inflation and real damage. Gee, what could go wrong?

Time to fill the forth and final job of alternatives in a portfolio: protection against inflation and currency devaluation. We discussed the first three jobs in previous columns (over there on the left); and for the complete story, please check out my new Harper Collins book, The Alternative Answer.

Gold, of course, is the classic inflation hedge, but you already know lots about that. Treasury Inflation Protected Securities, TIPS, are another top choice, but are also well known. Its more fun to look at some sleepers.

Art, for example. Its performance during times of inflation and rising interest rates has been excellent, easily outperforming stocks during those times. And it is an interesting play on globalization: as the world becomes more homogenous and networked, demand for recognized quality pieces keeps rising.

Now, you might think of art as a novel investment class, but many European aristocrats have preserved their wealth this way for generations. And art is much more enjoyable to have around the house than a pile of gold bars.

Still and all, neither gold nor art pays a coupon. On one level, the benefits of that are entirely obvious. On another, they’re more subtle. That’s because, as likely as inflation appears, there still remain powerful deflationary pressures, too (which is why all that money printing is going on, after all). And a great antidote to deflation is current income: so investing in real assets that also provide yield is a double-purpose move.

There aren’t so many, but there are some. Timber is a favorite of Harvard, and, when you think about it, its easy to understand why. It’s fully renewable, generates annual income, and has solid fundamental support: as the world’s middle classes grow, its use in homebuilding does too.

But maybe the most interesting thing about trees is the way you can “store on the stump.” Instead of selling in a bad year, when the market down, you can just defer the harvest and let them get bigger. With commercial real estate, a year of lost income is lost forever; not so with timber.

Farmland is similar, although it requires more current investment and management, and you do have to sell crops into bad markets periodically. It, too, has fundamentals going for it: the same growing middle classes that need to build homes demand more protein in their diets, so requiring more food for both people and animals. Price trends here have been very strong, some might say frothy; but the long-term investment case remains solid. (Just don’t forget to buy that crop insurance!)

Infrastructure assets, like toll roads, airports, and power generation facilities also throw off income and appreciate during inflation, and are a top choice for larger investors. Various forms of asset-backed lending can also work; my favorite: slot machines.

Now, I know what you’re thinking: these all sound great, but how do I invest in them? Well, first, here’s how not to: ETFs. There are all sorts of “timber” or “agriculture” ETFs but they invest in public companies that own these sorts of assets, not the assets themselves. That is a huge difference. Investing in companies means investing in management teams, not assets; and it also means riding the general ups and downs of the market, which is definitely not the point.

Instead, you’ll probably have to go to less liquid formats to get the benefits of these inflation busters. Direct ownership, of course, works just fine. But traditional privately placed partnerships can be very attractive, since you probably want an expert to select and manage the investments for you (certainly you do with art), and you usually want diversification that pooled investment delivers.

But a new type of hybrid vehicle might be best: “registered privates”. These are for accredited investors only, but most people really worried about wealth protection will qualify. The benefits are that, as SEC-registered funds, they provide strong investor protections and, usually, much lower minimum investments. And they mostly offer pretty good liquidity (usually quarterly)… not the same as daily, but acceptable given the nature of the underlying assets.

Of course, much more detail to come on these strategies and vehicles in future columns; and of course, you can learn more immediately by picking up The Alternative Answer.

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